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Wall Street and Sports Betting: An Introduction to the Ludic Fallacy

A headline in Wired’s November 2010 issue reads, “Wall Street Firm Uses Algorithms to Make Sports Betting Like Stock Trading.” After reading the article, I’m not sure if this development is good or bad for skeptical empiricists.

The headline left me with a fleeting impression; at first I brushed the story off as another silly antic from the inescapable depths of the ludic fallacy. I figured that this article, like any other sensationalized media, overstated the significance of the story. Unfortunately, after reading the article, the opposite rang true.

Enter the Future of Sports Betting

In Las Vegas, the M Resort Spa and Casino opened a new kind of “sports-wagering emporium.” Complete with wireless trading tablets, a 120,000-line computer program named Midas, decades of sports data, and fifteen years of development, the M certainly happened upon a Black Swan of sports gambling.

Indeed, from a business perspective, Cantor Gaming, the brainiac behind the phenomenon, developed a lucrative new model for sports betting. Most casinos shy away from sports because it is harder to calculate the odds of a baseball game than a game of craps. Cantor solved this problem by letting junkies bet on virtually anything—from the odds of Johnny Peralta getting on base to the New Orleans Saints’s drive resulting in a touchdown. As is standard, the house takes a commission, called the vigorish, on each and every bet. Cantor’s logic says that if the house takes enough bets, and Midas sets accurate lines, and the betting win-loss distribution appears normal, then the vigorish will yield a substantial profit for the house. Further, as Midas records new data and the programmers refine the algorithm, Midas should make increasingly accurate predictions, thus creating a more normal distribution of betting outcomes. This normalcy sings greater profit margins to the tune of more accurate loss predictions.

Sure, this looks great on paper. Key words: on paper. The reality of the situation maintains that reality is utterly unpredictable. Games like craps have calculable odds—the House Edge predicts profit. Herein lies the problem: confusing reality with games.

The Ludic Fallacy Comes to the Rescue

If you have yet to read The Black Swan, then let me take a moment to introduce you to the ludic fallacy. Originally coined by Taleb from the Latin ludus meaning “game,” the ludic fallacy describes any attempt to represent real-life situations with mathematical models and algorithms based on “studies of chance and the narrow world of games and dice.”

Most often used to refute stock market predictions and analytical economists, the application here should be obvious. Andrew Garrood, mathematician and lead developer of the Midas algorithm, said it best:

There is absolutely no difference between making prices for currency or making lines for sporting events. You don’t know if the market will go up or down any more than you know who will win the next horse race.

On the other hand, casinos supply entertainment, while economies provide people with an income or a savings account. The former puts much less risk in the gambler’s hand; falling prey to the ludic fallacy in the latter produces economic collapse.

Indeed, Cantor gaming is on to something. As Taleb explained, history progresses in leaps and bounds—large, unforeseen events characterize the shifts in trends and technologies. And in the gaming industry, this development certainly fits the description of a Black Swan. Forget about whether gambling on reality is a smart use of one’s money—it’s not. Period. Allowing people to bet on virtually anything and capitalizing on the normalcy of the outcomes cannot work. Although, that is not the point. Cantor’s success is an example of a well-designed product. Lee Amaitis, CEO of Cantor Gaming, explains, “My job is not to judge the morality of why people gamble. My job is to invest in and create things that make money for my partners.” What makes money, sells. And what sells, appeals to the customer.

My conviction: this development is actually good. You have junkies gathering in dark casino rooms sipping Coke & CC tapping glowing screens in response to bigger glowing screens gambling away the money they probably won through random occurrences anyway. Negligible is the impact of a Black Swan here on you and me; nobody is betting your mortgage. However, if this industry continues to grow, as I feel it will, it would ultimately fall into the same trap as the banking industry, which came inches away from collapsing the entire US economy. The model isn’t scalable: eventually a Black Swan will occur that fatally wounds Cantor Gaming. Sometimes we must take a step backward before we can continue forward. Hopefully, Cantor’s inevitable failing will educate more people to the traps of the ludic fallacy.